Tax & admin · 29 March 2017

Are you prepared for the flat rate VAT changes?

Flat rate VAT changes
It could now make sense to switch over to standard VAT reporting

First announced in November’s Autumn Statement, and soon to be brought into effect, the flat rate VAT changes are set to squeeze under pressure small businesses.

The battle to make sure businesses large and small pay the right amount of tax has often taken centre stage when the chancellor makes his Budget announcements. Whether it was plans to increase NICs for the self-employed (which was quickly abandoned) or efforts to ensure multinationals aren’t able to siphon profits off shore, the framework seemingly changes very year.

One amendment small business owners need to be aware of is the alternation to flat rate VAT – due to increase at the beginning of the financial year on 1 April. First introduced more than ten years ago, it was laid out to make tax simpler for small business owners.

A standard rate of 14.5 per cent was levied, meaning companies could pay a fixed rate to HMRC if turnover was below the £150,000 threshold. With the current VAT level standing at 20 per cent, that meant a company could keep the “money in the middle” – the amount produced after the 20 per cent VAT charged on goods and 14.5 per cent paid on the gross sale. It should also be added that different trades pay different flat rate VAT rate.

The government decided upon the policy in 2004 because it acknowledged the process of remaining VAT compliment and paying the right amount can be cumbersome and time-consuming for business owners – many of whom have little experience of the task.

Now, however, for limited cost business owners (those spending less than two per cent of total sales on goods in a specified accounting period) the flat rate VAT level will be set at 16.5 per cent – effectively eroding any middle margin they were able to hold onto.

Essentially, businesses based on a service, such as web designers, public relations or even accountants, will feel the change most acutely as each spends more on labour rather than materials.

As small business owners will know, any business turning over more than £83,000 a year must register for VAT and then charge it on services rendered. Those turning over less than that count can elect to register, as it has its advantages, or simply pay VAT to the tax man.

The idea of the flat rate VAT scheme was to simply make life easier and eliminate the need for complicated VAT returns and paperwork.

With the rate set to rise to 16.5 per cent, it reflects the government’s desire to remove such an incentive for slightly bigger businesses to remain below the £150,000 level and get exposure to that buffer amount.

On a bill of £1,000, a business could have held on to £2.60 after charging 20 per cent VAT but paying HMRC 14.5 per cent. Going forward, that rate will rise to 16.5 per cent on the gross cost (after VAT has been applied), meaning only 20p is gained from registering for the flat rate VAT rate.

For a number of companies in the UK, it may well be the time to move over to standard VAT reporting. The cost savings will be negligible and it will prepare finance teams for a time when growth takes them out of that turnover bracket and into a field with the big boys.

Conversations with your accountant will determine what the best course is for your specific business, but make sure you aren’t caught out by these changes.

Have a look at whether you’re at risk of making these common VAT mistakes?

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Hunter Ruthven was previously editor of Business Advice. He was also the editor of Real Business, the UK's most-read website for entrepreneurs and business leaders at the helm of growing SMEs.

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